Egypt’s Hard Economic Choices

Since the early days of the revolution, Egypt’s policymakers have been battling two main economic challenges: maintaining a stable value of the local currency in the face of growing balance of payment deficit, and securing resources to finance an expanding budget deficit. These two battles seem to have reached a critical juncture by the end of 2012, when a series of adverse developments hit Egypt’s fragile economy.

In the final three weeks of 2012 a preliminary deal with the International Monetary Fund (IMF) for a crucial $4.8 billion loan was postponed; Egypt’s sovereign credit rating was cut to “junk” status (same as Greece) by Standard & Poor’s (S&P); foreign exchange reserves reached an alarming “critical minimum”; the Egyptian pound slid to a record low not seen in eight years; and a budget deficit for the current fiscal year, ending on June 30, that could very well exceed initial projections by 50 percent.

Still, 2013 brought even more bad news: $5 billion in foreign investments had left the country during the second half of 2012; Moody’s placed Egypt bond ratings on review for possible downgrade; and a new World Bank report projected a 2.6% growth rate for Egypt this year, much lower than the government estimate of 4%. These developments are all interrelated, and better analyzed and understood in the wider post-revolution macroeconomic context which, for two years now, continues to be mired in political strife and policy uncertainty.

On the monetary side, and since January 2011, the Central Bank of Egypt (CBE) has been struggling to keep downward pressure off the pound, amid continued dwindling of foreign cash receipts from foreign investment and tourism. In the process, CBE was losing an average of $1.4 billion a month in an attempt to defend the national currency. By April 2012, Egypt foreign reserves were down to $15 billion from their January 2011 level of $36 billion; a level enough to cover 3 months’ worth of imports. Since mid-2012, dollar-and euro-dominated debt securities’ sales, and a total of $4 billion from Saudi Arabia, Qatar and Turkey deposited in CBE kept foreign-currency from falling below $15 billion.

Bonds sales and foreign deposits, however, only bought Egypt little time. By mid-December, signs of worsening international reserves position began to surface when banks started to bring dollars from their overseas accounts to meet growing local demand, followed, days later, by a government decree limiting foreign currency transfers in and out of Egypt to a max of $10,000 per traveler. A clear indication that the era of defending the national currency was over, however, came when CBE revealed that Egypt foreign reserves had plunged to a “critical and minimum level,” and announced the introduction of a new foreign exchange auction mechanism to buy and sell the US dollar.

Allowing Egypt’s pound to weaken had resulted in an 8% loss of its official value since mid-December. Whether this new policy of managing the country foreign exchange was an IMF loan-related condition or not, remains to be known. But for now, it is the inflationary impact of the pound fall that is of immediate concern in a country that imports 60% of its food and 40% of its fuel, and where over 25% of the population—50% in rural areas and city slums—live below poverty line. Add to this a jobless rate of 25% among young Egyptians, and the result is an explosive socioeconomic mix at hand.

On the fiscal front, Egypt has been facing a growing fiscal deficit which reached 11% of GDP (about $28 billion) last year, and is expected by the end of the current 2012/13 fiscal year to jump to 13% of GDP (close to $31 billion). With almost 80% of the state budget allocated to wages, subsidies and debt services, Egypt’s finance officials have little room for maneuvering. Raising taxes or cutting expenditure in the context of economic decline and rocky transition were not politically feasible and likely to carry a high social price. Borrowing, thus, seemed the only option left.

External official finances, however, were not readily available, and all seemed to be tied to Egypt undertaking necessary political and economic reform measures to ensure stability and sustainability of the country and its economy. And with Egypt’s international credit rating constantly on the decline (it has been downgraded five times by S&P since the revolution), borrowing from international markets was increasingly hard and costly. Post-Mubarak Egypt had twice approached the IMF, in May 2011 and again in January 2012, asking, then, for a $3.2 billion loan, and in both cases, internal domestic politics hindered a fruitful conclusion of the talks.

Egypt, thus, relied extensively on domestic borrowing, causing domestic debt to rise from 76% of GDP by end of 2010/11 fiscal year to 80% by end of fiscal year 2011/12. With external debt currently at $34.7 billion, or 13.5% of GDP, Egypt’s total public debt now is fast approaching the size of its economy. More worrying is the continued rise of government debt as a percentage of domestic banks’ total deposits and total credit, which amount to 55% and 56%, respectively. This high exposure to debt, for the country and its banking sector, partly explains the continued deterioration of their international credit standing.

Desperate for cash, Egypt turned, again in August 2012, to the IMF. This time asking for $4.8 billion loan; a 50% increase from the request made before. Three months later, a preliminary agreement was reached between the parties based on Egypt commitment to implement a homegrown economic reform program which aims to reduce the country’s budget deficit from 11% of GDP this year to 8.5% of GDP by 2014. This, according to the plan, is to be achieved, inter alia, through a mélange of tax hikes on sales, income and property, and through expenditure cuts. That loan arrangement is now on hold after Egypt retreated last December from raising sales taxes that were part of the IMF deal, hours after they were announced.

Given the sad state of its economy, Egypt is in dire need for the IMF’s support. With its foreign reserves already at rock bottom; its international credit rating recently “Greece-ed” by S&P; its cost of borrowing rising; and with the public debt, both domestic and external, reaching over 90% of GDP, Egypt is eager to conclude the IMF deal; not only for the $4.8 billion loan, but also to unlock additional international aid--about $10 billion—from a number of foreign countries and institutions that have conditioned their financial support to Egypt on finalizing the IMF deal.

But this will not be a panacea, nor will it be cost free. If faithfully implemented, the IMF-supported reform plan is certain to have inflationary consequences, some of which have already been felt by consumers around the country. Coupled with the inflationary impact of the pound’s fall, this could very well trigger waves of social unrest among the less-privileged, poverty-stricken Egyptian masses lacking social safety nets.

And this is where Egypt’s ultimate economic policy challenge this year lies: how to reconcile the high expectations of ordinary Egyptians for a better living, and respond to their passionate cry made two years ago this month at Cairo’s Tahrir Square for “bread, freedom and social justice,” while, at the same time, implement—in an increasingly chaotic political setting—a deeply unpopular IMF-required program that, in addition to the much-needed cash it will provide, is all but certain to inflict harsh economic pain on Egyptians’ lives and livelihoods. Finding a solution to this intricate puzzle will be Egypt’s leadership ultimate challenge in 2013.

Mohammed Samhouri is a Cairo-based economist and a former senior fellow and lecturer at Brandeis University’s Crown Center for Middle East Studies in Boston.

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